Week in Review

The Canadians like to think of themselves as kinder and gentler than their neighbors south of the border. For they have a generous welfare state. Including single-payer health care. Unlike those Americans who put profits before people. But it comes at a price. High taxes. And they do pay a lot. But they get a lot. Those high taxes, though, lower take-home pay. Giving Canadians less disposable income than their neighbors south of the border. Which means they have to borrow more to make up for that smaller disposable income (see Personal debt ratio hits record high of 163.7% posted 12/13/2013 on CBC News).

Statistics Canada reported Friday that the level of household credit market debt to disposable income increased to 163.7 per cent in the third quarter from 163.1 per cent in the second quarter.

That means Canadians owe nearly $1.64 for every $1 in disposable income they earn in a year.

Policymakers are fixated on the debt ratio in part because it was at above 160 per cent that households in the United States and Britain ran into trouble about five years ago, contributing to defaults and the financial crisis that triggered the 2008-09 recession…

Indeed, while they are borrowing more, Canadians are also worth more as their assets increase by a similar amount. The national net worth increased to $7.5 trillion in the third quarter, up 2.1 per cent from the previous quarter.

On a per capita basis, that works out to $212,700 for every Canadian. The previous quarter, that figure was $208,300.

Rising net worth and rising debt? Gee, what could that mean? Well, most people’s wealth is determined by the price of their home. As the value of their homes rise so does their net worth. That is, their net worth rises as the price of their home (if they were to sell) rises. And as their home price rises so do other home prices. Which increases mortgage amounts. As people borrow more to buy these more expensive homes. And the lower the interest rates the more they will borrow and the bigger the house they will buy. And this creates a what? That’s right. A housing bubble (see Is There a Canadian Housing Bubble? by Carrie Rossenfeld posted 11/13/2013 on GlobeSt.com).

GlobeSt.com: What factors lead experts to think there may be a Canadian housing bubble?

Muoio: For us, the biggest sign there is a housing bubble is how far prices have appreciated without a corresponding rise in income. This means housing affordability is falling rapidly and will eventually reach a tipping point. Additionally, if lenders are underwriting against an expectation of rising prices, this could result in loosening standards and too much leverage in the system.

GlobeSt.com: How similar are these factors to what happened to the US housing market before the recession?

C.M.: Very similar. US home prices kept appreciating while incomes saw only modest growth in the final years before the bubble burst. This led to a situation where eventually housing just became entirely unaffordable and the market’s liquidity completely dried up. With people over-levered due to the loose lending standards (which were enabled by the expectation of rising prices), this led to a massive unwind and foreclosure mess we are still working through. Additionally, Canada, just like us at the time, is building an extreme amount of homes that could lead to oversupply issues.

A rising debt level and higher net worth probably is more bad news than good. For it is likely a sign of a housing bubble. Just like these very things were a sign of a housing bubble in the U.S. just before the subprime mortgage crisis. Or is it a sign that Canadians are just taxed too much leaving them with less disposable income? Forcing them to borrow more as they cannot save enough for a sizeable down payment to reduce the amount they have to finance? Or is it both?

It appears the Canadians can’t learn from the Americans. And when the Canadian bubble bursts the Americans won’t learn anything from the Canadians. For governments today want to keep interest rates low to encourage home ownership. Which they do. Taking us from bubble to bubble. And from recession to recession.

Week in Review

Since the Keynesians took over monetary policy we’ve had the Great Depression, the inflation racked Seventies, the dot-com bubble/recession of the late 1990s/early 2000s and the subprime mortgage crisis. It’s also given Japan their Lost Decade, a deflationary spiral that started in the late Eighties that they are still fighting today. As well as the sovereign debt crisis still ongoing in Europe. So Keynesian economics has a record of failure. Yet governments everywhere embrace it. Why? Because they love having the power to create money. Especially when it’s ostensibly for helping the economy. Which it never does. As efforts to do so resulted in the carnage noted above. But it always gives a good excuse for another surge in government spending. And Keynesians love government spending.

Now, Alan Greenspan has struck back at any notion that he — or anyone — could have known how or when to defuse the threats that triggered the crisis. He argues in a new book, The Map and the Territory, that traditional economic forecasting is no match for the irrational risk-taking that can inflate catastrophic price bubbles in assets like homes or tech stocks.

This is why the Soviet Union lost the Cold War. Because their managed economy failed. As all managed economies fail. Because it is impossible to know the decisions of hundreds of million people in the market. These people making decisions for themselves result in economic activity. But when governments try to decide for them you get Great Depressions, debilitating inflation, bubbles and nasty recessions. As well as the collapse of the Soviet Union.

People only took irrational risks when the Federal Reserve (the Fed)/government interfered with market forces. The dot-com bubble grew because the Fed kept interest rates artificially low. So was it irrational for people to take advantage of those artificially low interest rates and make risky investments they otherwise wouldn’t have made? Yes. But if the Fed didn’t keep them artificially low in the first place there would have been no dot-com bubble in the second place.

Was it irrational for people to buy houses they couldn’t afford when the Clinton administration forced lenders to qualify the unqualified for mortgages they couldn’t afford? Was it irrational behavior for people to buy houses they couldn’t afford because of artificially low interest rates, ‘cheap’ adjustable rate mortgages, zero-down mortgages, interest only mortgages and no-documentation mortgages? Yes. But if the Fed/government did not interfere with market forces in the first place to increase home ownership (especially among those who couldn’t qualify for a conventional mortgage) there would have been no subprime housing bubble in the second place.

The problem with Keynesians is they call anyone who doesn’t behave as they hope to make people behave with their policies irrational. That is, people are irrational if they don’t think like a Keynesian and therefore cause Keynesian policies to fail. But before there could be irrational exuberance there has to be a climate that encourages irrational exuberance first. For if we went back to the banking system where our savings rate determined our interest rates as well as the investment capital available there would be no bubbles. And no irrational exuberance. What kind of a banking system would that be? The kind that vaulted the United States from their Founding to the number one economic power in the world in about one hundred years. And they did that without making money. Unlike today.

Q: The size of the Federal Reserve’s balance sheet stands at a record $3.7 trillion, reflecting all the Treasurys and mortgage-backed securities the Fed has bought to push long-term interest rates down. You have expressed concerns about this size, which is more than four times where the balance sheet stood before the start of the financial crisis. What are your worries?

A: My basic concern is that we have to rein this thing in well before the demand for funds picks up and makes it very difficult to rein in. (Inflation) is not immediate. It is down the road. But historically, there are no cases where central banks blow up their balance sheets or where countries print money which doesn’t hit (with higher inflation).

The balance sheet is four times what it was before the Great Recession? That’s an enormous amount of new money created to stimulate the economy. And yet we’re still wallowing in the worst economic recovery since that following the Great Depression. I don’t know how much more you can prove the failure of Keynesian economics than this. About five years of priming the economic pump with stimulus stimulated little. Other than rich Wall Street investors who are using this easy money to make more money. While the median household income falls.

Keynesian economics attacks the middle class. While enriching the ruling class. And their crony friends on Wall Street. These policies further the divide between the rich and everyone else. Yet they continually say these same policies are the only way to reduce the divide between the rich and everyone else. The historical record doesn’t prove this. And those familiar with the historical record know this. Which is why the left controls public education. So people don’t learn the historical record. Because once they do it becomes harder to win elections when you’re constantly lying to the American people.

Economics 101

Housing Sales drive the Economy because almost Everything for Sale is for the Household

Once upon a time the rule of thumb was to buy the most expensive house we could possibly afford. We saved 20% for a down payment on a conventional mortgage. We lived on a shoestring budget and paid our mortgage no matter what. Even if we had to live on meatloaf and macaroni and cheese for the next five years. Or longer. We did this because we would be paying that mortgage payment for 30 years. And though tough at first during those 30 years we advanced in our careers. And made more money along the way. Making that mortgage payment easier to pay as time went by.

So that was the way it used to be. And it was that way for a long time. Until the Federal Reserve started playing with interest rates to stimulate economic activity. Altering the banking system forever. Instead of encouraging people to save their money so banks could loan money to homebuyers they printed money. Flooded the market with it. Ignited inflation. And caused housing bubbles. Then the government took it up a notch.

Housing sales drive the economy. Almost everything for sale is for the household. Furniture and appliances. Beds and ceiling fans. Tile and paint. Cleaning supplies and groceries. Dishes and cutlery. Pots and pans. Towels and linen. Lawnmowers and weed-whackers. Decks and patio furniture. When people buy a house they start buying all of these things. And more. Creating a lot of economic activity with every house sold. So the government did everything they could to encourage home ownership. And few governments did more than the Clinton administration. By applying pressure on lenders to qualify the unqualified for mortgages. Which gave us the subprime mortgage crisis.

Lenders used Subprime Lending to Qualify the Unqualified to Comply with the Clinton Administration

People in poor neighbors tended to be poor. And unable to qualify for a mortgage because they couldn’t afford the house payments. When these poor people happened to be black the Clinton administration said the banks were racist. They were redlining. And advised these lenders that if they don’t start qualifying these people who couldn’t afford a house that the full weight of the government will make things difficult for them to remain in the lending business. So they complied with the Clinton administration. Using subprime lending to put people into homes they couldn’t afford.

The main reason why people can’t afford to buy a house is the size of the mortgage payment. Which can be pretty high if they can’t afford much of a down payment. So these lenders used special mortgages to bring that monthly payment down. The adjustable rate mortgage (ARM). Which had a lower interest rate than conventional mortgages. Because they could raise it later if interest rates rose. Zero-down mortgages. Which eliminated the need for a down payment. Coupled with an ARM when interest rates were low could put a poor person into a good sized house. No-documentation loans. Which removed the trouble of having to document your earnings to prove you will be able to make your house payment. Making it easier to approve applicants when you don’t have to question what they write on their application. Interest-only loans where you only had to pay the interest for, say, 5 years. Greatly reducing the size of the monthly payment. But after those 5 years you had to pay that loan back in full with a new mortgage for the full value of the house. Which may be more costly in 5 years.

So these lenders were able to meet the Clinton administration directive. They were putting people into homes they couldn’t afford. Just barely. These people had house payments they could just barely afford. Thanks to the low interest rate of their ARM. But then interest rates rose. Making those mortgage payments unaffordable. With zero-down they had little to lose by walking away. And a lot of them did.

The Interest on the Debt is so large we have to Borrow Money to Pay for the Cost of Borrowing Money

Buying a house is a huge investment. One that we finance. That is, we borrow money. Sometimes a lot of it. Because we don’t want to wait and save money for a down payment. And because we want so much right now we buy as much as we can with those borrowings. Doing whatever we can to lower the monthly payment. With little regard to long-term costs. For example, assume a fixed 30-year interest rate of 4.5%. And we finance a $150,000 house with zero down. Because we have saved nothing. The monthly payment will be $790.03. But if we waited until we saved enough for a 10% down payment that monthly payment will only be $684.03. And if we saved enough for 20% down the monthly payment will only be $608.02. That’s $182.01 less each month. The total interest paid over the life of this mortgage for zero down, 10% down and 20% down is $123,610.07, $111,249.06 and $98,888.05, respectively. Adding that to the price of the house brings the total cost for that house to $273,010.07, $246,249.06 and $218,888.05, respectively. So if we wait until we save a 20% down payment we will be able to buy a $150,000 house and $54,723.02 of other stuff during those 30 years. This is the opportunity cost of debt.

We are better off the less we finance. Because long-term debts are with us for a long time. And they don’t go away if we lose our job. Or if interest rates go up. Like with an ARM. A large driver of the subprime mortgage crisis. Let’s see what was happening before the housing bubble burst. Let’s say we could buy that $150,000 house with a zero down mortgage with an adjustable interest rate of 2%. Giving us a monthly payment of $554.43. Very affordable. Which helped get a lot of people into houses they couldn’t afford. But then the interest rate went up. And what did that do to someone who could just barely pay their house payment when it was $554.43? Well, if it reset to 4% that payment increased to $716.12 ($161.69 more per month). If it reset to 6% that payment increased to $899.33 ($344.90 more per month). Bringing the total cost of the house to $323,757.28 ($150,000 principle + 173,757.28 interest). Which is why a lot of these people walked away from these houses. There was just no way they could afford them at these higher interest rates.

Interest payments on long-term debt at high interest rates can overwhelm a borrower. Making the Clinton administration’s Policy Statement on Discrimination in Lending insidious. It destroyed people’s lives. Putting them into houses they couldn’t afford with subprime lending. But if you think that’s bad consider the national debt. These are long-term obligations just like mortgages. And currently we owe $16,738,533,025,135.63 (as of 9/13/2013). At an interest rate of 3.9% the annual interest we must pay on this debt comes to $652,802,787,980.29. That’s $652.8 billion. Which is more than we spend on welfare ($430.4 billion). Almost what we spend on Social Security ($866.3 billion). And more than half of the federal deficit ($972.9 billion). This is the opportunity cost of debt. It limits what we can spend elsewhere. On welfare. Social Security. Etc. The interest on the debt has grown so large that we even have to borrow money to pay for the cost of borrowing money. And there is only one way this can end. Just like the subprime mortgage crisis. Only worse.

Week in Review

Counterfeiting money is against the law. We all know this. But do we understand why? Today’s money is just fiat money. The Federal Reserve prints it and simply says it is money. So why is it okay for them to print money but not for anyone else? Because the amount of money in circulation matters.

The goods and services that make up our economy grow at a given rate. You hear numbers like GDP of 2%, 3% or more. In China they had GDP numbers in excess of 8%. The goods and services in our economy are what have value. Not the money. It just temporarily holds the value of these goods and services as they change hands in the economy. So the amount of money in circulation should be close to the value of goods and services in the economy. Think of a balancing scale. Where on the one side you have the value of all goods and services in the economy. And on the other you have the amount of money in circulation. If you increase the amount of money on the one side it doesn’t increase the amount of goods and services on the other side. But it still must balance. So as we increase the amount of money in circulation the value of each dollar must fall to keep the scale in balance.

Now when we put our money into the bank for our retirement we don’t want the value of those individual dollars grow less over time. Because that would reduce the purchasing power of our money in the bank. Making for an uncomfortable retirement. This is why we want a stable dollar. One that won’t depreciate away the value of our retirement savings, our investments or the homes we live in. We’d prefer these to increase in value. But we can stomach if they just hold their value. For awhile, perhaps. But we cannot tolerate it when they lose their value. Because when they do years of our hard work just goes ‘poof’ and disappears. Leaving us to work longer and harder to make up for these losses. Perhaps delaying our retirements. Perhaps having to work until the day we die. So we want a stable currency. Like the gold standard gave us (see Advance Look: What The New Gold Standard Will Look Like by Steve Forbes posted 5/8/2013 on Forbes).

The financial crisis that began in 2007 would never have happened had the Federal Reserve kept the value of the dollar stable. A housing bubble of the proportions that unfolded–not to mention bubbles in commodities and farmland–would not have been possible with a stable dollar. The Fed has also created a unique bubble this time: bonds. It hasn’t popped yet (nor has the farmland bubble), but it will.

The American dollar was linked to gold from the time of George Washington until the early 1970s. If the world’s people are to realize their full economic potential, relinking the dollar to gold is essential. Without it we will experience more debilitating financial disasters and economic stagnation.

What should a new gold standard look like? Representative Ted Poe (R-Tex.) has introduced an original and practical version. Unlike in days of old we don’t need piles of the yellow metal for a new standard to operate. Under Poe’s plan–an approach I have long favored–the dollar would be fixed to gold at a specific price. For argument’s sake let’s say the peg is $1,300. If the price of gold were to go above that, the Federal Reserve would sell bonds from its portfolio, thereby removing dollars from the economy to maintain the $1,300 level. Conversely, if the gold price were to drop below $1,300, the Fed would “print” new money by buying bonds, thereby injecting cash into the banking system.

Yes, the subprime mortgage crisis and the Great Recession would not have happened if the Federal Reserve kept the dollar stable. Instead, they kept printing and putting more money into circulation. Why? To keep interest rates low. To encourage more and more people to buy a house. Even people who weren’t planning to buy a house. Even people who couldn’t afford to buy a house. Until, that is, subprime lending took off. Because of those low interest rates. With all of these people added to the housing market who otherwise would not have been there (because of the Federal Reserve’s monetary policies of printing money to keep interest rates artificially low) the demand for new houses exploded. As people tried to buy these before others could house prices soared. Creating a great housing bubble. Houses worth far greater than they should have been. And when the bubble burst those housing prices fell back to earth. Often well below the value of the outstanding balance of the mortgage on the house. Leaving people underwater in their mortgages. And when the Great Recession took hold a lot of two-income families went to one-income. And had a mortgage payment far greater than a single earner could afford to pay.

So that’s how that mess came about. Because the Federal Reserve devalued the dollar to stimulate the housing market (and any other market of big-ticket items that required borrowed money). If we re-link the dollar to gold things like this couldn’t happen anymore. For if it would put a short leash on the Federal Reserve and their ability to print dollars. How? As they print more dollars the value of the dollar falls. Causing the value of gold priced in dollars to rise. So they would have to stop printing money to keep the value of gold priced in dollars from rising beyond the established gold price. Or they would have to remove dollars from circulation to decreases the value of gold priced in dollars back down to the established price. Thereby giving us a stable currency. And stable housing prices. For having a stable currency limits the size of bubbles the Federal Reserve can make.

But governments love to print money. Because they love to spend money. As well as manipulate it. For example, depreciating the dollar makes our exports cheaper. But those export sales help fewer people than the depreciated dollar harms. But helping a large exporter may result in a large campaign contribution. Which helps the politicians. You see, a stable dollar helps everyone but the politicians and their friends. For printing money helps Wall Street, K Street (where the lobbyists are in Washington DC) and Pennsylvania Avenue. While hurting Main Street. The very people the politicians work for.

Week in Review

Those people who can afford to pay a little more? Those 50-year olds in established careers? Those people President Obama has been relentlessly attacking as being greedy and selfish? They appear to be killing themselves in record numbers (see Suicide rate rose sharply among middle-aged Americans, CDC finds by Atossa Araxia Abrahamian posted 5/2/2013 on Reuters).

The suicide rate among Americans aged 35 to 64 rose sharply between 1999 and 2010, a trend that could reflect the stresses of a sharp economic downturn as well as other traditionally overlooked challenges of middle age, according to a federal report released on Thursday.

The annual rate of suicide rose 28 percent among Americans aged 35 to 64 during the study period, but changed little for older and younger people, the Centers for Disease Control and Prevention said. The number of suicides among people in their 50s doubled in that time frame…

The increase in the U.S. over the past two decades may also reflect the influence of the weak economy – suicides generally rise during downturns – and an increase in the use of prescription opioid painkiller drugs, the CDC said.

The U.S. economy twice went into recession during the study period, briefly in 2001 and sharply during the so-called Great Recession of December 2007-June 2009 that sent the unemployment rate as high as 10 percent…

In 2010, there were 33,687 U.S. deaths from motor vehicle crashes, compared to 38,364 suicides, according to the CDC.

Suicides kill more than cars. And cars kill more than guns. Yet the Obama administration is putting all of their efforts behind new gun control legislation. Instead of trying to stop something that kills more Americans then guns or cars. A bad economy.

This is an indictment of Keynesian economics. Alan Greenspan kept interest rates artificially low during the Nineties. Keynesian-style. People were borrowing that cheap money and making a lot of bad investments with it. Greenspan called it irrational exuberance when testifying before Congress. And later admitted that he waited too long to start raising interest rates. Which is why the early 2000s recession was such a painful one. After the dot-com bubble burst. All those dot-coms that had no profits or even a product to sell went belly up. After irrational investors had poured billions into them. Raising the market value of publicly traded Internet companies to over a trillion dollars. Most of which disappeared after the bubble burst.

Bud did the Keynesians in Washington learn? No. They went back to keeping interest rates artificially low. Creating a housing bubble. An even more insidious one. Going beyond irrational exuberance. Thanks to Bill Clinton’s Policy Statement on Discrimination in Lending. Using the full weight of the federal government to force lenders to qualify the unqualified. Creating a housing bubble full of toxic subprime loans. And when this bubble burst the recession was so bad we had to put the word ‘Great’ in front of it.

A terrible one-two punch for those in the workforce building their families and their retirement portfolios. Thanks to Keynesian economics and those artificially low interest rates. Which only lead to great big bubbles. That burst into great big recessions. Can you imagine someone losing big in the early 2000s recession? Working hard to recover their losses? And just get back on track only to see their mortgage go underwater in the Great Recession? Forcing them to dip into what little there was remaining in their retirement accounts. While they are taking care of their kids. Their aging parents. And hearing their doctors say for the first time in their life, “Your blood pressure is a little high.”

Perhaps the government should spend less time trying to outlaw guns and more time on the economy. And by more time I mean less. They need to pull the government out of the private sector economy. And let market forces take over. Including those interest rates. Perhaps then they can stop one of the greatest killers in our lives. Keynesian economics. That take us from exuberant highs. To crushing lows. Wiping out our finances in the process. Leaving us filled with despair. Which is probably why suicide rates have soared in the past decade. Because of the Keynesian policies of our government. Those failed policies of the past that they refuse to let go of.

Economics 101

Building and Furnishing Houses creates Great Economic Activity

Central to any booming economy are healthy home sales. For home sales unleash great economic activity. From the first surveys of a new subdivision. To the new sewers and water systems. Gas and telephone. Cable television and broadband Internet. Concrete for basements, driveways and sidewalks. Structural steel (that beam in the basement and steel poles holding up the house). Rough carpentry. Electrical work and plumbing. Drywall, windows and roofing. Painting, flooring, doors and hardware. Heating and air conditioning. Lighting and plumbing fixtures. Brick, siding and landscaping. Etc.

All of this takes manufacturing to make these construction products. All these manufacturers need raw materials. And raw material extraction needs heavy equipment and energy. At all of these stages of production are jobs. Extracting raw materials. Processing raw materials. Manufacturing products out of these raw materials. Building this production equipment. Interconnecting these stages of production is every form of transportation. Rail, Great Lake freighter, river barge and truck. Requiring even more jobs to build locomotives, rolling stock, ships and trucks. And jobs to operate and maintain them. And build their infrastructure. Filling all of these jobs are people. Earning a paycheck that will let them buy a house one day.

Then even more economic activity follows. As people buy these homes and furnish them. Washers and dryers. Refrigerators, stoves, microwaves, food processors and coffee makers. Furniture and beds. Light fixtures and ceiling fans. Rugs, carpeting and vacuum cleaners. Telephones, televisions, music systems, modems and computers. Curtains, drapes, blinds and shades. Shower curtains, bath mats, towels and clothes hampers. Mops, buckets, cleaning supplies and waste baskets. Lawnmowers, fertilizers, hoses and sprinklers. Snow shovels and snow blowers. Cribs, highchairs, diapers and baby food. Etc. All of these require manufacturers. And all of these manufacturers require raw materials. As well as transportation to move material and product between the stages of production. And to our wholesalers and retailers. More jobs. More people earning a paycheck. Who will one day buy their own home. And create even more economic activity.

Bill Clinton pressured Lenders to Lower their Requirements and Subprime Lending took Off

This is why governments love housing. And try to do everything within their power to increase home ownership. Which is why they changed the path to home ownership. After World War II when the building of subdivisions took off there was the 3-6-3 savings and loan. Where savings and loan paid 3% interest on savings accounts. Loaned money to home buyers at 6%. And were on the golf course by 3 PM. And the mortgage was the 30-year conventional mortgage with a 20% down payment.

The conventional mortgage was the mortgage of our parents. Who had no problem putting off their wants to save money for that 20% down payment. They prioritized. And planned for the future. But the conventional mortgage has an obvious drawback. It limits home ownership to those who can save up a 20% down payment. Pushing home ownership further out for some. Or just taking that option away from a large percentage of the population. So the government stepped in. To help those who couldn’t save 20% of the house’s price.

As we lowered the down payment amount it allowed lower-income people the opportunity of home ownership. But it didn’t get them a lot of house. That is, those who could afford a 20% down payment could buy more house for the same monthly payment than those who couldn’t afford it. And a house in a better neighborhood. Which some said was unfair. Some in government even called it discriminatory. As Bill Clinton did. Who pressured lenders to lower their lending requirements to qualify the unqualified. His Policy Statement on Discrimination in Lending helped to fix that alleged problem. And kicked off subprime lending in earnest. Leading to the subprime mortgage crisis. And the Great Recession.

Conventional Wisdom was to Pay the Most you could Possibly Afford when Buying a House

But lowering the down payment wasn’t enough. Even eliminating it all together. The people needed something else to help them into home ownership. And to generate all of that economic activity. And this was something the government could fix, too. By printing a lot of money. So banks had a lot of it to lend. Thus keeping interest rates artificially low. And we can see the effect this had on home ownership combined with a zero down payment. It allowed people to buy more house for the same given monthly payment. Even more than those buying with the 3-6-3 conventional mortgage.

Falling interest rates bring in a lot more people into the housing market. Which is good for sellers. And good for the economy. A lot more people than just those who could afford a 20% down payment can now buy your house. As people bid against each other to buy your house they bid up your price. Raising home prices everywhere. Increasing the demand for new housing. Which builders responded to. Creating a housing boom. As builders flood the market with more houses. At higher prices. That new homeowners move into. And max out their credit cards to furnish. Creating a lot of debt people are servicing at these artificially low interest rates. But then the economy begins to overheat. And other prices begin to rise. Leaving people with less disposable income. The housing boom turns into a housing bubble. House prices are overvalued. Those artificially low interest rates created a lot of artificial demand. Bringing people into the market who weren’t planning on buying a house. But decided to buy only to take advantage of those low interest rates.

Conventional wisdom was to pay the most you could possibly afford when buying a house. For all houses gained value. You may struggle in the beginning and have to make some sacrifices. Say cut out steak night each week. But in time you will earn more money. That house payment will become more affordable. And your house will become more valuable. Which will let you sell it for more at a later date letting you buy an even bigger house in an even nicer neighborhood. But when it’s cheap interest rates driving all of this activity there is another problem. For printing money creates inflation. And inflation raises prices. Gasoline is more expensive. Groceries are more expensive. As prices rise households have less disposable income. And have to cut out things like vacations. And any discretionary spending on things they like but don’t need. Which destroys a lot of economic activity. The very thing the government was trying to create more of by printing money. So there is a limit to the good economic times you create by printing money. And when the bad consequences of printing money start filtering through the rest of economy the government has no choice but to contract the money supply to limit the economic damage. And steer the economy into what they call a soft landing. Which means a recession that isn’t that painful or long.

The Price of Artificially Low Interest Rates is Inflationary Booms, Bubbles and Great Recessions

As interest rates rise home buying falls. Leaving a lot of newly built homes unsold on the market. And that housing bubble bursts. Causing home values to fall back down from the stratosphere. Leaving a lot of people owing more on their mortgage than their houses are now worth. What we call being ‘underwater’. And as interest rates rise so do the APRs on their credit cards. As well as their monthly payments. And those people who paid the most they could possible afford for a house with an adjustable rate mortgage saw their mortgage interest rates rise. As well as their monthly payment. By a lot. So much that these people could no longer afford to pay their mortgage payment anymore. As a half-point increase could raise a mortgage payment by about $50. A full-point could raise it close to $100. And so on.

With the fall in economic activity unemployment rises. So a lot of people who have crushing credit card debt and a house payment they can no longer afford lost their job as well. Causing a rash of mortgage foreclosures. And the subprime mortgage crisis. As well as a great many personal bankruptcies. Causing the banking system to struggle under the weight of all this bad debt. Add all of this together and you get the Great Recession.

This is the price of artificially low interest rates. You get inflationary booms. And bubbles. That burst into recessions. That are often deep and long. Something that didn’t happen during the days of 3-6-3 mortgage lending. And the primary reason for that was that the U.S. was still on a quasi gold standard. Which prevented the government from printing money at will. The inflationary booms and busts that come with printing money. And Great Recessions.

History 101

LBJ was able to pass JFK’s Tax Cuts resulting in a Long Period of Economic Growth

The official unemployment rate is stuck around 8%. But if you count all the people who can’t find a full-time job the actual unemployment rate is closer to 14%. With every jobs report we hear the positive spin from the government about another down tic in the official unemployment rate. And the hundreds of thousands of new jobs created. But after three years or so of hearing these reports people start questioning the numbers. And the rosy spin. Because despite all the good news they tell us people are disappearing from the civilian labor force. Which is the only reason why the official unemployment rate is falling. Because they’re not counting a lot of unemployed people. So looking at the civilian labor force may be a better indicator of the health of the economy. Or better yet, the civilian labor force participation rate (CLFPR). Which is basically the percent of those who can work that are working. So let’s do that. Starting with the Fifties.

After World War II veterans went to college on the G.I. Bill. These new college graduates with degrees in science, engineering and business management entered the workforce in the Fifties. Helping the United States to develop new technologies. New industries. And a lot of new jobs. American wells were busy pumping domestic oil. Keeping gasoline cheap. Having escaped the damage of war the American economy exported to those countries that didn’t. And consumer spending took off. Thanks to the new advertising industry telling Americans about all the great things to buy. They bought houses and cars with borrowed money. And used the new credit card to spend even more money they didn’t have. Changing the American economy into a consumer-based economy. Making the Fifties one of the most prosperous times in U.S. history. Despite the Korean War. And the Cold War. Which was getting underway in a big way. There was a burst of inflation to help pay for the Korean War. When it ended they contracted the money supply to get rid of that inflation sending the economy into recession. But once the recession ended the economy took off with all that consumerism. Shown by the sharp rise in the CLFPR. To correspond with the very good economic times of the Fifties. Another monetary contraction happened in 1957 to tamp out some price inflation. With a corresponding fall in the CLFPR.

The Sixties started with another recession. After it ended, though, the CLFPR continued to fall. The recession was officially over but the economy was not doing well. The CLFPR fell for almost three years following the recession. Things were different from the Fifties. For one, a lot of those war-torn economies were up and running again. Providing some competition. Especially a little island nation by the name of Japan. Which one day would build all the televisions sold in America. It was because of this fall in economic activity that JFK started talking about tax cuts in 1963. Congress blocked his attempt to cut tax rates. But after his assassination LBJ was able to pass the Revenue Act of 1964. This lowered the top marginal tax rate from 91% to 70%. And lowered the corporate income tax from 52% to 48%. Among other favorable business measures. Resulting in a long period of economic growth. And a long upward trend in the CLFPR.

The Tax Cuts and Deregulation of the Eighties created one of the Longest Periods of Economic Growth

But following the Revenue Act of 1964 came the Great Society. The Vietnam War. And the Apollo moon program. All paid for with a huge surge in federal spending. Deficits began to grow. As the government struggled to pay for everything. And were unwilling to cut anything.

The economy fell into a mild recession in 1970. The CLFPR remained relatively flat. To meet their spending needs they started printing money. Devaluing the dollar. Still part of Bretton Woods the dollar was still pegged to gold at $35/ounce. That is, the U.S. agreed to exchange gold for dollars at $35/ounce. But as they devalued the dollar our trading partners no longer wanted to hold dollars. Because they were losing their purchasing power. They wanted the gold instead. So they began exchanging their dollars for gold. Causing a great outflow of gold from the U.S. Causing a problem for President Nixon. He didn’t want the U.S. to lose all of their gold reserves. But he didn’t want to cut any spending. Which meant he didn’t want to stop printing money. In fact, he wanted to print more money. And the easy way out of his dilemma was by doing the most irresponsible thing. He slammed the gold window shut in 1971. And refused to exchange gold for dollars anymore. And when he did there was no restriction to the amount of money they could print. And they printed it. A lot. Creating double-digit inflation before the Seventies were over. The inflation caused prices to rise. Which Nixon tried to prevent with wage and price controls. Causing a shortage of available rental property as people converted them into condos to get away from the rent control. Gasoline stations ran out of gas as people filled their tanks with below-market priced gas. And meat disappeared from grocery stores. Wage controls kept wages from keeping pace with inflation. So even though people had jobs they lost more and more purchasing power. Or simply found there was nothing to purchase. Throwing the economy into recession in 1973. After the recession the CLFPR grew throughout the remainder of the Seventies. But it wasn’t good growth. It was growth sustained with double-digit inflation. A bubble of artificial economic activity. That would have to crash. As all inflationary periods must crash.

In the Eighties Paul Volcker, Federal Reserve Chairman, raised interest rates to double digits to wring out the double-digit inflation from the economy. To restore people’s purchasing power. And return the nation to real economic growth. The tax cuts and deregulation of the Eighties created one of the longest sustained periods of economic growth in U.S. history. With one of the longest upward trends in the CLFPR ever. Indicating a growing economy. With more and more people who could work finding work. Proving that Reaganomics worked. And worked very well.

If JFK or Ronald Reagan were President Today we wouldn’t be seeing a Freefall of the CLFPR

But it wouldn’t last. Thanks to the government’s interference into the banking industry. They had set a maximum limit on interest rates S&Ls (and banks) could offer. When inflation took off people pulled their money from their savings accounts. Putting it in higher earning instruments. So they didn’t lose their savings to inflation. This bad banking policy begat more bad banking policy. They deregulated the S&Ls and banks. So they could do other things to make up for their lost savings business. And that other thing was primarily real estate. They borrowed short-term money to make long-term loans. Helping to create a housing bubble. And when they began to wring that inflation out of the economy interest rates rose. When those short-term loans came due they had to refinance them at higher interest rates. While the interest they were earning on those long-term loans remained the same. So their interest expense soon exceeded their interest income. Creating the savings and loan crisis. And a severe recession that ended the economic expansion of the Eighties. With a corresponding fall in the CLFPR.

Once the recession ended the CLFPR resumed a general upward growth. But not as good as it was in the Eighties. Also, it would turn out that much of the growth in the Nineties was artificial. Bill Clinton’s Policy Statement on Discrimination in Lending forced lenders to lower their lending requirements. And to qualify the unqualified. Which created a surge in subprime lending. And the beginning of a housing bubble. The Internet entered the economy in the Nineties. Just as the personal computer entered the economy in the Eighties. Making Bill Gates a very rich man. Investors were anxious to find the next Bill Gates. Taking advantage of those low interest rates creating that housing bubble. And poured money into dot-com start-ups. Companies that had no revenues. Or products to sell. Creating a dot-com bubble. And a surge in computer programming jobs. Also, as the century came to a close there was the Y2K scare. Creating another surge in computer programming jobs. To rewrite computer code. Changing 2-digit date codes (i.e., ’78) to 4-digit codes (i.e., 1978).

The Y2K scare proved to be greatly overblown. Which put a lot of computer programmers out of a job in January of 2000. And they wouldn’t find a dot-com job for the dot-com bubble burst in the same year they lost their Y2K job. Throwing the economy into recession in 2001. And then making everything worse came the terrorist attacks on 9/11. Prolonging the recession. As can be seen by the long decline in the CLFPR. Which leveled out after the Bush tax cuts. But then that housing bubble peaked in 2006. And burst in 2007 into the subprime mortgage crisis. Thanks to all those toxic mortgages Bill Clinton’s Policy Statement on Discrimination in Lending forced lenders to make. And because Fannie Mae and Freddie Mac bought these toxic mortgages and had Wall Street package them into collateralized debt obligations this crisis spread worldwide. Selling what they told unsuspecting investors were high yield, low risk investments. Because they were backed by the safest of all loans. Mortgages. What they failed to tell these investors was that these mortgages were not safe 30-year conventional mortgages. But highly risky subprime mortgages. In particular adjustable rate mortgages. Where the monthly payment would increase with an increase in interest rates. And that is what happened. And when it happened the unqualified could not afford the new monthly payment. And defaulted. Kicking off the Great Recession. And because President Obama was more interested in national health care than ending the Great Recession he didn’t cut taxes. Or cut regulations. Instead, he increased taxes and regulations. Making the current recovery one of the worst in U.S. history. As can be seen in the greatest decline in the CLFPR since the Great Depression. If you look at a continuous graph from 1950 to the present you can see just how bad the Obama economic policies are.

The JFK and Reagan tax cuts caused the greatest economic expansions. And the greatest rise in the CLFPR. Also, after most recessions there was a return to a growing CLFPR. Interestingly, the two times that didn’t happen are tied to Bill Clinton. Who created two of the greatest bubbles. The dot-com bubble in the Nineties. And the subprime mortgage bubble that was built in the Nineties and the 2000s. The growth was so artificial in building these bubbles that the CLFPR did not recover following the bursting of these bubbles. It might have following the dot-com bubble if the subprime mortgage crisis didn’t follow so soon after. The current recovery is so bad that it has taken the CLFPR back to levels we haven’t seen since the Seventies. Making the current recovery far worse than the official unemployment rate suggests. And far worse than the government is telling us. So why are they not telling us the truth about the economy? Because the government wants to raise taxes. And if the economy is improving there is no need for recession-ending tax cuts. So they say the economy is improving. As they hate tax cuts that much. Unlike Ronald Reagan. Or JFK. And if either of them were president today we wouldn’t be seeing a freefall of the CLFPR.

Week in Review

Governments like people buying houses. Because it is the biggest engine of economic activity. Generated from building houses. And then furnishing them. And they’ll do just about anything to encourage people to buy houses. No matter the damage it can cause. As we’ve recently learned. But that hasn’t stopped government from making the same mistakes (see Budget 2013: The good, the bad and the ugly by Sam Bowman posted 3/20/2013 on Adam Smith Institute).

Bank guarantees to underpin £130bn of new mortgage lending for three years from 2014. Apparently the Treasury has not learned the lesson of 2008: injecting taxpayer money into the housing sector will simply inflate prices, distorting price signals and stoking the housing bubble that already seems to be growing in the housing sector. Houses are expensive because supply is restricted by the planning system. Instead of throwing money at the problem and driving prices up even more, the government should have the courage to liberalize planning to allow more development, including on green belt land.

Government ministers picking winners. Fiddling with tax breaks for specific industries is a mug’s game. There is no way the government can know which industries to promote, and these projects inevitably collapse into a mess of overcomplicated grant schemes and politics-driven bailouts of failing firms. Only consumers can pick winners.

Government spending is still rising. Despite all the talk of cuts, the government will still be spending £761bn this year, nearly £20bn more than last year. By leaving healthcare alone and failing to carry out the big structural reforms needed to reduce social security spending, the government is not matching its rhetoric on spending with the action needed. We’re still going to be borrowing £108bn this year – that’s £295m a day, every day, with no end to the borrowing in sight.

While those on the Left blame Wall Street and greedy banks for the subprime mortgage crisis the British press knows who was at fault. The U.S. government. They’re the ones who kept interest rates artificially low. Creating a housing bubble. It was Bill Clinton who pressured lenders to make bad loans (to fix discrimination in lending that was not there). This is why banks turned to subprime lending. And the adjustable rate mortgage (ARM). To qualify the unqualified. Which they only did because Fannie Mae and Freddie Mac guaranteed those loans. Even buying them to get them off of the banks’ books. So the U.S. government caused the subprime mortgage crisis. Not Wall Street. Or greedy bankers.

Land use restrictions have long kept housing prices high. Rich people have used their influence with government to restrict new housing in some very nice areas. You can’t build new housing in some of the most exclusive neighborhoods. Which keeps housing availability low. Housing prices high. And the ‘undesirables’ out of these rich people’s neighborhoods. Allowing the rich to stick with their own kind.

Friends of the government get special favors. Solyndra gets government loans to produce something there is no market for. They go bankrupt. Yet the government continues to spend money to pick winners the market passes on. Some things never change. No matter where you are.

Wherever you look these days governments give examples of what not to do. Yet no one ever heeds these warnings. And they make the same mistakes over and over again. No matter how bad those mistakes were. And as far as mistakes go, few were as bad as all the bad policy decisions that led up to the subprime mortgage crisis. Yet President Obama has already talked about doing more of the same. As are the British. Why? Because of that insatiable desire governments have to spend. It has toppled empires in the past. And yet they still spend. As they will always continue to spend. Because spending gives them power. Which trumps everything else. Even the trust of the people.

Week in Review

Investors like rising stock prices. They don’t like falling stock prices. Which is why Wall Street likes inflation. And fear deflation. Even though the economy is still sluggish with more and more people dropping out of the labor market (which is why the unemployment rate fell) investors are bullish. Because of the Federal Reserve and all of their quantitative easing.

The more the Fed increases the money supply the more inflation there will be. Investors like that. Because inflation increases prices. Such as the prices of their stocks. As well as gasoline and groceries. Making the current economic times odd. For the stock market recently reached a record high. Even though the labor participation rate (see THE EMPLOYMENT SITUATION —FEBRUARY 2013, page 4) continues to fall. It is now at 63.5%. Which means 89,304,000 people are not in the labor force. A record high. But you wouldn’t know this by looking at the official unemployment rate. Or the stock market (see Stocks And Inflation: The End Of An (Abnormal) Affair? by James Picerno posted 3/69/2013 on Seeking Alpha).

The positive correlation between the market’s inflation forecast and the stock prices appears a bit looser these days, but it’s premature to declare that the link has been broken…

Normally, rising/high inflation doesn’t inspire the bulls. But the last several years have been less than normal in terms of the macro backdrop. The crowd has remained worried about disinflation/deflation, which means that signs of higher inflation in the future have soothed anxious traders…

And why not? For when have inflationary policies ever caused an asset bubble? That burst into a long and painful recession? Except the housing bubble that brought about the 1990-91 recession. The dot-com bubble that brought about the 2000-01 recession. And that other housing bubble that brought about the 2007-09 recession. AKA The Great Recession. So there is no worry that these record highs in stock prices aren’t just another bubble. Just waiting to burst. Bringing on another deflationary recession. I mean, what are the odds of that happening again?

Actually, the chances are pretty good that 2013 will have a very painful recession. Because we don’t have any real economic growth. These gains in the stock market aren’t because businesses are expanding and hiring. Not with a falling labor participation rate. No. For all intents and purposes we are still in the 2007-09 recession. Only we should probably call it the 2007-(end date to be determined) recession. Because the president’s economic policies haven’t helped the economy yet. And probably never will.

There’s no reason to believe that the fifth year will be any better than the previous four years. In fact, it will probably be worse. In fact one would almost get the impression that he is not trying to help the economy. But, instead, trying to destroy the Republican Party. So he can win the House of Representatives back in 2014. So he can pass even more anti-business policies. To transform the country into something it was never before. Less prosperous than communist China.

Week in Review

It’s not been a good year for Detroit. Well, it’s been more than a year. It’s been a few bad years. Actually, it’s been a great many bad years. Since 1970. When Ford Motor Company Chairman Henry Ford II joined with other business leaders to form Detroit Renaissance. To revitalize the City of Detroit. And some 42 years later, the City of Detroit is still struggling (see Detroit’s Misery Can Be Its Turning Point by Micheline Maynard posted 2/23/2013 on Forbes).

Detroit boosters were dealt a one-two blow this week by the kind of outsiders they have come to resent.

First, a state review panel declared that a financial emergency existed in the city, making it likely that Michigan Gov. Rick Snyder will appoint an emergency financial manager with sweeping powers.

Then, Forbes weighed in by declaring Detroit the nation’s most miserable city, based on a series of criteria that include crime, unemployment, foreclosures and home value…

Although General Motors is based in Detroit, and Chrysler recently opened an office there, the automobile industry is not going to provide the vast numbers of jobs the city needs to become solvent.

And there lies the problem for Detroit. A city that grew big and rich off of the automobile industry saw a steady exodus and a declining tax base when the automobile industry declined. Live by the automobile. Die by the automobile. And it’s just not Detroit. A couple of other Michigan cities broke into the top 10 of Forbes’ America’s Most Miserable Cities 2013.

#7 Warren, Mich.

Troy and Farmington Hills are part of the government-defined Warren metro division. Like Detroit, the Warren metro has seen home prices collapse–off 53% the past five years.

#2 Flint, Mich.

Flint has been demolishing homes as the city shrinks with residents leaving in search of jobs. Only Detroit has a higher net out-migration rate. Flint ranks third worst for violent crime, behind Detroit and Memphis.

#1 Detroit, Mich.

Violent crime in the Detroit metro was down 5% in 2011, but it remains the highest in the country with 1,052 violent crimes per 100,000 people, according to the FBI. Home prices were off 35% the past 3 years, which is the biggest drop in the U.S.

If you seek a pleasant peninsula* you’d do better looking for one where the UAW isn’t dominant. Perhaps Florida. For the UAW is a city killer based on these Michigan cities. (*The official state motto of Michigan is “If you seek a pleasant peninsula, look about you.”)

The Big Three dominated these cities. Where fat pay and benefit packages were passed on to consumers in overpriced vehicles. The Big Three’s monopoly on car sales allowed them to make fat profits. And pay enormous amounts of taxes to the cities that had the factories that assembled their cars. City coffers were so flush with cash city governments grew. And city workers enjoyed fat pay and benefit packages. This was the high water mark of the UAW. Just after public sector unions had joined them on the gravy train. But then something happened that devastated the UAW. Consumers got choice. They no longer had to buy overpriced ‘rust buckets’ the Big Three was putting out during the Seventies. For the Japanese gave them choice.

And so began the great decline of the Big Three. Quality and value did them in. It’s what the people wanted. While the UAW wanted consumers to pay more and get less. So they could continue to enjoy their fat pay and benefit packages. As the jobs went away so do did the taxes. The cities bloated with all those government workers with their fat pay and benefit packages tried to maintain the size of their governments even while the tax base was declining. Reducing other government services as they had little money left over after paying those fat pay and benefit packages.

With fewer and fewer jobs available people left these cities. Empty houses dotted the horizon. And housing prices fell. With the tax base continuing to decline. Poverty rates rose. As did city services for the impoverished. Leaving even less for other city services. Causing a further exodus from the city. Urban blight followed. As did crime. Causing a further decline in property values.

Low interest rates helped boost housing prices. For awhile. President Clinton’s Policy Statement on Discrimination in Lending kicked off subprime lending in earnest as lenders bowed to the Clinton Justice Department to put more low-income and minorities into homes they couldn’t afford. Creating a huge housing bubble. Built on easy credit. Artificially low interest rates. And the adjustable rate mortgage (ARM). When rates went up all those low-income and minorities who bought houses they couldn’t afford defaulted on their higher mortgage payments. Creating the subprime mortgage crisis. Giving us the Great Recession. Creating a flood of foreclosures. A free fall in housing prices. And more of the same that helped put those three Michigan cities into the top ten of Forbes’ America’s Most Miserable Cities 2013.

Michigan recently opted to become a Right-to-Work state. Greatly angering the UAW and those public sector unions. But it may be just what Michigan needs to reverse the great decline caused by the UAW and the public sector unions that devastated some of Michigan’s greatest cities. One thing for sure it can’t get any worse. Not when being a union state for so long secured three places in the top ten of Forbes’ America’s Most Miserable Cities 2013.